21 Nov 2023, 08:43
Julian Wettengel

Germany’s govt coalition wrangles over budget after “debt brake” court ruling

The German parliament building. Image by CLEW
The German parliament building. Image by CLEW

The debates over the fallout of last week’s shock constitutional court ruling on Germany’s state budget borrowing rules are in full swing, as the government faces difficult decisions on how to fill a 60-billion-euro gap in its special fund for climate and transformation. The ruling has increased already high tensions within the three-party coalition over how to finance the country’s transition to climate neutrality, with some members advocating for more subsidies, while others are calling for stricter market-based instruments, such as carbon pricing. Controversial ideas to fill the immediate financing gap include spending cuts, raising taxes or the national CO2 price, and declaring yet another emergency situation, which would allow the government to exceed the constitutional cap on state debt. Economy minister Robert Habeck said the court ruling would hit German industry hard, because billions earmarked for subsidies to help companies decarbonise are now at risk. [UPDATE adds finance ministry decision to freeze federal budget spending pledges for future years]

The constitutional court ruling from 15 November on Germany’s special budget for climate and transformation has thrown the debate over the country’s state budget and how to fill the 60-billion-euro gap wide open. Members of the coalition government of chancellor Olaf Scholz’s Social Democrats (SPD), the Green Party and the Free Democratic Party (FDP) have floated several different, sometimes conflicting, proposals, which will make finding a compromise difficult.

The options being discussed include spending cuts, raising taxes or the national CO2 price, and declaring yet another emergency situation, which would allow the government to exceed the constitutional cap on state debt. However, all of these options face criticism within the government, which is still analysing the complete fallout of the ruling, and has announced its first decisions for the coming days.

As a first step, several media reported that the finance ministry on Monday night (20 November) announced it would freeze almost all future spending pledges in order to avoid up-front burdens for future years. This applied to all federal ministries, but constitutional bodies like parliament or the president are exempt. Commitments already made would not be affected.

The ruling by Germany’s highest court on the government’s budget planning declared the current funding mechanism for 60 billion euros in climate policies unconstitutional. The judges ruled that chancellor Olaf Scholz’s coalition government cannot use funds initially dedicated to respond to the coronavirus pandemic to fill Germany’s long-term Climate and Transformation Fund. The ruling could also have consequences for other special state funds, for example because the court said emergency funds introduced as an exception to the debt brake could not be used over several years.

[Also read a Q&A on what the German top court’s ‘debt brake’ ruling means for climate policy]

Coalition dispute over how to fill the 60-billion-euro gap

It remains unclear whether any climate programmes would face budget cuts, and if so which. The government could make substantial changes to the budget to move certain programmes out of the Climate and Transformation Fund. However, for now the coalition faces the difficult task of filling a 60-billio-euro gap.

The Climate and Transformation Fund — set up as the Energy and Climate Fund in 2011 — is only one of several special-purpose funds outside of the regular state budget, which also exist for other areas, including defence spending.

Most of the fund is currently being used for retrofitting buildings to make them more energy-efficient, which together with support for renewable energy remain the biggest expenditures in the years until 2027, according to government plans. In addition, billions from the fund are earmarked for industry decarbonisation, e-mobility, the hydrogen economy and semiconductor funding, as well as investments in Germany’s rail system. For the years 2024 to 2027, the government has planned total expenditures of 212 billion euros from the fund. However, without the 60 billion euros in credit authorisations, the fund faces a gap of almost 20 billion euros already in 2024.

The coalition could seek more state revenues to fill at least part of the gap. One option to tackle the issue would be to increase taxes, as climate and social NGOs have proposed. However, the FDP opposes any tax increases and the coalition agreement ruled these out.

“Of course, I know which coalition agreement we are bound by, so we have to scrape together some money and reallocate it,” economy minister Habeck said in an interview with public broadcaster Deutschlandfunk (Dlf). “But, of course, this money is earmarked for other things, so there's a gap for the time being.”

FDP parliamentary group head Christian Dürr said Germany had to consider cuts in the social welfare system. “We must also discuss where the welfare state can make its contribution to budget consolidation," Dürr told Funke Mediengruppe. However, this does not go down well with coalition partners from the SPD and the Green Party, reported Tagesschau.

Green Party co-head Ricarda Lang proposed to cut fossil fuel subsidies to come up with more funding leeway for climate action. The Federal Environment Agency (UBA) has said that Germany's total of climate-damaging and environmentally harmful subsidies exceeds 65 billion euros annually. However, some these subsidies include benefits for businesses, which the FDP has opposed to be struck, such as tax benefits for company cars.

Increasing the national CO2 price on transport and heating fuels could be another option to raise state revenues. However, economy minister Habeck warned that raising it so much that it would fill the 60-billion-euro gap would be a stark increase, which would result in the population losing trust in the government. Matthias Miersch, deputy head of the Social Democrats’ parliamentary group, even warned that a stark increase would only benefit the far-right, populist Alternative for Germany (AfD).  “An exploding CO2 price is a stimulus programme for the AfD," he told Süddeutsche Zeitung. The Social Democrats have in the past often cautioned against a steep rise of carbon prices.

Another option on the table is to declare an emergency situation to allow the state to borrow more money than the debt brake normally allows. Economy minister Habeck in the Dlf interview did not explicitly rule out this option, but economists have warned against it. This would not be the right way, said the president of the Germany's Institute for Economic Research (ifo), Clemens Fuest, in a message on X. “The energy price shock is over, permanently high energy prices and decarbonisation are major challenges, but not an emergency in the sense of the debt brake.” Economist Veronika Grimm warned that this “risky” option could once again fail at the constitutional court, and emphasised that climate action is a long-term task, so Germany would have to completely overhaul its climate policy and how it is financed. 

Some politicians and experts have also called for a reform of the debt rule. Monika Schnitzer, head of the German Council of Economic Experts, proposed to change the rule in the constitution to allow for more debt to enable the state to support investments for example in the field of climate action. However, to reform the debt brake, a two-thirds majority in parliament would be necessary, and it is not likely that the opposition conservatives would agree.

Court ruling to hit industry hard, not so much climate protection – economy minister

The court ruling will hit the country’s industry in transition harder than it is going to be an issue for climate protection, Habeck told Dlf.

“The core substance of the German economy is being challenged by the ruling,” he said. “The court case does less harm to climate protection than it does to the German economy.” In addition to expenditures for programmes to renovate buildings and support renewable energy, the government has earmarked about 4 billion euros to support industry decarbonisation and the ramp up of the hydrogen economy from the Climate and Transformation Fund in 2024.

In the interview, Habeck argued that with the 60-billion-euro gap, industry modernisation was now at risk, if subsidies could not be given. “We would have less CO2 emissions in Germany not because we have a green industry, but because we have a less powerful industry,” Habeck said, adding that “half of the world” was subsidising industry transformation, making it extremely competitive.

Business daily Handelsblatt reported that especially energy-intensive industry is worried about a possible lack of support. "With regard to our decarbonisation projects, we are disappointed and above all concerned," Reiner Blaschek, Germany head at steel manufacturer ArcelorMittal, told the newspaper. He said "a perspective for industrial production in Germany in line with the transformation" was lacking.

Especially the planned Carbon Contracts for Difference (CCfDs) subsidy programme to compensate energy-intensive companies for the extra costs of climate-friendly production was now at risk, Handelsblatt reported.

Next challenge looming

The ruling could also have severe consequences for other energy and climate funding schemes set up in recent years. The court said that emergency funding would have to be used in the year of the crisis – not be spread out over several years, as was the case with the Climate and Transformation Fund. Thus, the ruling also challenges the 200-billion-euro “defence shield,” which the government introduced last year to protect citizens and companies from rising energy prices. As a funding vehicle, the government used the Economic Stabilisation Fund – originally set up to support the economy during the pandemic.

“The ruling also applies to the Economic Stabilisation Fund, which we will have to deal with,” Habeck told Dlf. The 200 billion euros have been used, for example, to finance subsidies to cap gas and electricity prices – an ongoing measure, which the coalition has recently decided to extend into 2024.

“In plain language, this means that citizens might have to pay higher electricity and possibly higher gas prices in the future,” Habeck said. The government had decided to use about 5 billion euros in 2024 from the fund to pay for rising grid fees, and thus keep electricity prices in check. This was now at risk, he said. “You can thank [opposition CDU leader] Friedrich Merz.” While journalists have called the ruling a “damning verdict on the government’s financial policy,” the minister puts at least some of the blame for the fallout of the ruling on the conservative CDU/CSU alliance of former chancellor Angela Merkel. Conservative lawmakers had challenged the re-direction of the coronavirus funds before the constitutional court, leading to the ruling.

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